  Roger Lowenstein, author of the best-selling Buffett: The Making
of an American Capitalist, reported for The Wall Street Journal for more than a
decade, and wrote the Journal’s stock market column “Heard on the
Street” from 1989 to 1991 and the “Intrinsic Value” column from 1995 to
1997. He now writes a column in Start Money magazine, and has written for The
New York Times and The New Republic, among other publications. He has three children and lives in Westfield, New Jersey. (This interview was conducted by Haym Benaroya, October 2000.) Summary
of When Genius Failed: The rise and fall of Long-Term Capital Management is a tale
of financial genius and arrogance. Long-Term took a highly mathematical approach to bond
trading as devised by academics, two of the firm’s partners, who won the Nobel Prize
in economics before the bottom fell out. In 1996, Long-Term's profits of $2.1 billion
overshadowed those of the most successful corporations. But by the fall of 1998, Long-Term
had lost 77 percent of its capital. It was then forced into the position of having the
Federal Reserve Bank of New York broker a bail-out deal with financial firms who were at
risk because of their financial dealings with Long-Term. This book explains what these
very smart men did and how it all came crashing down. There are many lessons to be
learned, one that comes to mind being: knowledge is limited regardless of how
sophisticated the models. Resonance: I have just
finished reading your latest book, When Genius Failed: The Rise and Fall of Long-Term
Capital Management. It is a very interesting book to read. I didn’t expect to
find a book written as a novel, with protagonists and, in some eyes, villains and heroes.
I enjoyed it very much. Lowenstein: Villains may be the wrong word-nobody
threw a baseball bat or went to jail, right? But the story has a natural dramatic tension
and, hopefully, this builds with every page. Resonance: If I understand the details accurately, the main
thesis of your work is that the reason Long-Term Capital Management (LTCM) imploded was
because it was allowed, by the rules, to buy options using essentially 100% borrowed
moneys. Have the rules on leveraging and debt changed since the time you completed writing
this book? Lowenstein: Borrowed money or, alternatively,
using derivatives, which requires "no money." The latter are just side bets that
in LTCM's case required no money down. The rules haven't changed. But banks have gotten a
lot tougher, so credit availability has diminished. Resonance: You mentioned
that Meriweather (JM), the founder and head of LTCM, and some of his colleagues, have
created a new and similar fund, since the collapse of LTCM. Do you follow their progress
and do you know if their new funds are similar to the ones that collapsed? Are they a more
stable and responsible fund, or are we all skating on thin ice again? Lowenstein: Again, JM has let credit to work
with this time, and as the book notes, his new fund is working with less leverage. I doubt
very much that we will see a sequel. Resonance: Are there
many hidden risks in the markets today, any of which could bring down the markets
precipitously? Lowenstein: They aren't hidden. The Internet
stocks have been a bubble waiting to burst--of course, though in my opinion not all of the
bursting has already been seen. The reason these fiascoes keep coming back is that
speculation visits a different area every time. Resonance: In your
opinion, was it a mistake to bailout LTCM? Or would we have a more stable and less
volatile system today if the fund and its investors were allowed to absorb all losses? Lowenstein: Acknowledging that the Fed did not,
of course, "bail out" LTCM--it invited private banks and tacitly encouraged them
to do the job--I think the more proper course would have been to stay out completely. I do
not think the system or markets would have been paralyzed, as some officials testified was
their fear, and I think the resulting losses and even temporary confusion would have sent
a needed dose of discipline to investors and, importantly, to creditors and banks. Resonance: When I was
reading about the collapse of LTCM, I started to feel sorry for the partners, not
intellectually but emotionally. You wrote about their personal tragedies along the way
down. Of course, they took many people and organizations down with them, and one could
easily argue that they all deserved much worse than they received. But, is this an
irrational reaction? Did you have similar thoughts? Lowenstein: As a writer you try to imagine and
convey to the reader what the people in the story are think about and feeling, or at least
try to convey the pressures and feelings they are subjected to. But you try not to get
wrapped up in the feelings yourself. Resonance: How long did it take you to conceive,
research and write When Genius Failed? Lowenstein: About 18 months, including the
editing process. Resonance: Long-Term was
populated with Ph.D.s from elite institutions, a couple of Nobel Prize winners in
economics, and many other very “smart” people. How could they have been so
wrong? Lowenstein: Their intelligence helped lead to
their downfall. It helped to spawn their overconfidence, which led to their levels of
risk. Resonance:
On a very narrow level, the rise and fall of LTCM parallels the management of our
involvement in Vietnam. Defense Secretary McNamara and company, also very smart people,
believed they could approach the war using rational systems analysis techniques.
But they were dealing with an enemy that wasn’t going to allow some equations to
govern their behavior. This phenomenon of “very smart people going in very wrong
directions” seems to happen not that rarely. Do you see this as well? Lowenstein: It's a good
parallel. Buffett says there are many people who are smart enough and even smarter than
necessary to succeed in investing and also other realm. People succeed or fail depending
on how they apply their brains. Another Buffett-ism is knowing your limits. McNamara &
Co. didn't realize that all of their "systems analysis" etc. wouldn't count for
much in the lowland delta, etc. of Indochina. LTCM made a similar mistake. Resonance: When did you start believing that your
career would center about writing, and business/finance in particular? Did your family
support you in your decision to become a writer? Lowenstein: I often mused about writing, novels
and so forth, as a kid, but my career started taking shape in college, when I worked
(nearly round the clock) for my school paper, The Cornell Daily Sun. My folks let know
they'd be happy no matter what I did as long as it was something that turned me on.
They're tickled pink now. Resonance: Did you read the business pages as a
youngster? Lowenstein: Certainly not. Resonance: What are some of your skills that
permitted you to succeed as a writer? Lowenstein: I hard work, I'm articulate, I have
an ear for language, and I read a lot. Resonance: Following up on
the previous question, it is always interesting to learn about how a particular author
goes about his writing. Is a computer used? What are the working habits? For example, is
an outline first written? The general question is, what are the mechanics of the process? Lowenstein: Yes, a laptop, and yes, I do make an
outline. In the LTCM book it was relatively easy because the chronology more or less
imposed itself on the story. However, I did switch the order of two chapters at the last
minute-just before I sent them to the publisher-really on impulse! … When in the
midst of a book I get to work as early as I can and write for as long as I can. In between
books, such as now, the schedule is much more fluid. I'll work hard -sometimes very hard-
on an article and then have some time off. It's a very flexible routine, which I like. Resonance: You
wrote in an article in The Wall Street Journal in November 1997 predicting disaster
with stock options. Were there others also ringing the alarm bells? Why
was it easy to ignore the warning signs? Do you see other warning signs today? (Are CDs
the only place to be today?) Lowenstein: Watch those tech stocks! Don't go
long on real estate in Silicon Valley. And watch the dollar (vs. the Euro) -this too shall
pass! Resonance: Speaking to a young person of about
13-14 years old, just entering High School, what advice would you offer? Lowenstein: Read, write if the spirit moves you,
and read. Always read. Resonance: What do you do in
your free time? Do you have a few favorite web sites? Lowenstein: Read, hike, hang with the kids, run,
ride my bicycle, cook, not in that order. Nix on web sites. Resonance: If you could solve just one of this
nation’s problems, which one would it be? Lowenstein: Hmmm. I'd like to see people, especially young people, spending more time talking to each other, getting outside, reading books, and less time on-line or watching TV. I have no solution and doubt that one exists. |
